Definition
A Stop Order (also known as a stop-loss order) is a directive given to a securities broker to buy or sell a security at the market price once the security has traded at a specific price, referred to as the stop price. It is a type of market order that is activated once the stop price has been reached.
Examples
- Example 1: An investor buys shares of a company at $50 per share. To limit potential losses, the investor places a stop order to sell if the stock price falls to $45. If the stock drops to $45, the stop order becomes a market order and the shares are sold at the next available market price.
- Example 2: A trader owns a stock currently priced at $100 per share and expects its value to rise. To protect potential profits, they set up a stop order at $90. If the stock experiences a sudden drop to $90, the order instructs the broker to sell immediately, securing the profit from the drop’s outset.
Frequently Asked Questions
1. What is the primary purpose of a stop order?
The primary purpose of a stop order is to protect an investor’s profits or limit their losses by triggering a market order when the stop price is reached, ensuring immediate market execution.
2. How does a stop order differ from a limit order?
A limit order specifies the maximum or minimum price at which an investor is willing to buy or sell a stock, while a stop order becomes a market order to buy or sell once the stop price has been reached.
3. Can a stop order guarantee execution at the stop price?
No, a stop order does not guarantee execution at the stop price. Once the stop price is reached, it becomes a market order and is executed at the best available price, which may be higher or lower than the specified stop price.
4. Are there different types of stop orders?
Yes, there are mainly two types: a stop-loss order (to sell once a lower price is reached) and a stop-buy order (to buy once a higher price is reached).
5. When is it advisable to use a stop order?
It is advisable to use a stop order when an investor wants to limit their losses on a holding they own or ensure they miss out on potential profit erosion by buying into a security at a specific upside price point.
Related Terms
- Market Order: An order to buy or sell a security immediately at the best available current price.
- Limit Order: An order to buy or sell a security at a specific price or better.
- Stop-Limit Order: A combination of a stop order and a limit order, which becomes a limit order once the stop price is reached.
- Trailing Stop Order: An order set at a predefined percentage away from the current market price, adjusting as the price changes.
Online References
Suggested Books for Further Studies
- “Trading and Exchanges: Market Microstructure for Practitioners” by Larry Harris
- “A Beginner’s Guide to Stock Market: Learn The Basics of Stock Market” by John Border
- “Trading for a Living: Psychology, Trading Tactics, Money Management” by Dr. Alexander Elder
Fundamentals of Stop Orders: Securities Trading Basics Quiz
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